Capacity Strategy – Capacity Investment Appraisal
Operations Management Strategy
Outlines
Introduction Index Payback Method ( 回收期限法 ) Accounting Rate of Return ( 會計報酬率
法 ) Net Present Value (NPV, 淨現值法 ) Discounted Cash Flow ( 現金流量折現法 ) Internal Rate of Return (IRR, 內部報酬率
法 ) Profitability Index ( 利潤指數法 )
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3
Introduction
擴 廠
選擇設備 設備汰舊換新
購買 或 租借 成本降低
4
Cash Outflows
維修和保固
操作成本
期初投資資本
營運資本
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Cash Inflows
降低成本
殘餘價值
增加盈收
資本回收
Capacity Investment Appraisal
A means of assessing whether an investment project is worthwhile or not
Investment project could be the purchase of a new PC for a small firm, a new piece of equipment in a manufacturing plant, a whole new factory, etc
Used in both public and private sector
Capacity Investment Appraisal
Types of investment appraisal: Payback Period ( 回收期限法 ) Accounting Rate of Return
(ARR, 會計報酬率法 ) Internal Rate of Return (IRR,
內部報酬率法 ) Profitability Index ( 利潤指數
法 ) Net Present Value ( 淨現值法 )What factors need to be considered before
investing in equipment such as this?
Copyright: Gergely Erno, stock.xchng
Capacity Investment Appraisal
Investment Appraisal Why do companies invest?
Importance of remembering investment as the purchase of productive capacity NOT buying stocks and shares or investing in a bank!
Buy equipment/machinery or build new plant to: Increase capacity (amount that can be produced) which means:
Demand can be met and this generates sales revenue Increased efficiency and productivity
Investment Appraisal Investment therefore
assumes that the investment will yield future income streams
Investment appraisal is all about assessing these income streams against the cost of the investment
Not a precise science!A fork lift may be an important item but what does it contribute to overall sales? How long and how much work would it have to do to repay its initial cost?
Copyright: Loisjune, stock.xchng
Payback Method ( 回收期限法 )
Payback Method ( 回收期限法 ) The length of time taken to repay the initial
capital cost Requires information on the returns the
investment generates e.g. A machine costs £600,000 It produces items that generate a profit of £5 each
on a production run of 60,000 units per year Payback period will be 2 years
Payback could occur during a year Can take account of this by reducing the
cash inflows from the investment to days, weeks or years
Days/Weeks/Months x Initial Investment Payback = ------------------------------------------
Total Cash Received
Payback Method ( 回收期限法 )
Payback Method ( 回收期限法 ) e.g.
Cost of machine = £600,000
Annual income streams from investment = £255,000 per year
Payback = 36 x 600,000/765,000
= 28.23 months (2 yrs, 6¾ months)
Income
Year 1 255,000
Year 2 255,000
Year 3 255,000
Accounting Rate of Return ( 會計報酬率法 )
Accounting Rate of Return ( 會計報酬率法 )
A comparison of the profit generated by the investment with the cost of the investment
Average annual return or annual profit ARR = --------------------------------------------
Initial cost of investment
Accounting Rate of Return ( 會計報酬率法 ) e.g. An investment is expected to yield cash flows of £10,000
annually for the next 5 years The initial cost of the investment is £20,000 Total profit therefore is: £30,000 Annual profit = £30,000 / 5
= £6,000ARR = 6,000/20,000 x 100
= 30%A worthwhile return?
Investment Appraisal To make a more informed
decision, more sophisticated techniques need to be used.
Importance of time-value of money
Net Present Value (NPV, 淨現值法 )
Net Present Value (NPV, 淨現值法 ) Takes into account the fact that money values change with
time How much would you need to invest today to earn x
amount in x years time? Value of money is affected by interest rates NPV helps to take these factors into consideration Shows you what your investment would have earned in an
alternative investment regime
Net Present Value (NPV, 淨現值法 ) e.g. Project A costs £1,000,000 After 5 years the cash returns = £100,000 (10%) If you had invested the £1 million into a bank
offering interest at 12% the returns would be greater
You might be better off re-considering your investment!
Net Present Value (NPV, 淨現值法 ) The principle: How much would you have to invest now to earn £100 in
one year’s time if the interest rate was 5%? The amount invested would need to be: £95.24 Allows comparison of an investment by valuing cash
payments on the project and cash receipts expected to be earned over the lifetime of the investment at the same point in time, i.e the present.
Net Present Value (NPV, 淨現值法 )
Future ValuePV = -----------------
(1 + i)n
Where i = interest rate n = number of years The PV of £1 @ 10% in 1 years time is 0.9090 If you invested 0.9090p today and the interest rate was
10% you would have £1 in a year’s time Process referred to as:
‘Discounting Cash Flow’
Net Present Value (NPV, 淨現值法 ) Cash flow x discount factor = present value e.g. PV of £500 in 10 years time at a rate of
interest of 4.25% = 500 x .6595373 = £329.77 £329.77 is what you would have to invest today at
a rate of interest of 4.25% to earn £500 in 10 years time
PVs can be found through valuation tables (e.g. Parry’s Valuation Tables)
Cash Flows
Discounted Cash Flow ( 現金流量折現法 )
An example: A firm is deciding on investing in an energy
efficiency system. Two possible systems are under investigation
One yields quicker results in terms of energy savings than the other but the second may be more efficient later
Which should the firm invest in?
Discounted Cash Flow ( 現金流量折現法 )– System A
Year Cash Flow (£) Discount Factor (4.75%)
Present Value (£)(CF x DF)
0 - 600,000 1.00 -600,000
1 +75,000 0.9546539 71,599.04
2 +100,000 0.9113641 91,136.41
3 +150,000 0.8700374 130,505.61
4 +200,000 0.8305846 166,116.92
5 +210,000 0.7929209 166,513.39
6 +150,000 0.7569650 113,544.75
Total 285,000 NPV =139,416
Discounted Cash Flow ( 現金流量折現法 )– System B
Year Cash Flow (£) Discount Factor (4.75%)
Present Value (£)(CF x DF)
0 - 600,000 1.00 -600,000
1 +25,000 0.9546539 23,866.35
2 +75,000 0.9113641 68,352.31
3 +85,000 0.8700374 73,953.18
4 +100,000 0.8305846 83,058.46
5 +150,000 0.7929209 118,938.10
6 +450,000 0.7569650 340,634.30
Total 285,000 NPV =108,802.70
Discounted Cash Flow ( 現金流量折現法 )
System A represents the better investment System B yields the same return after six years but
the returns of System A occur faster and are worth more to the firm than returns occurring in future years even though those returns are greater
Internal Rate of Return (IRR, 內部報酬率法 )
Internal Rate of Return (IRR, 內部報酬率法 )
Allows the risk associated with an investment project to be assessed The IRR is the rate of interest (or discount rate) that makes the
net present value = to zero Helps measure the worth of an investment Allows the firm to assess whether an investment in the machine,
etc. would yield a better return based on internal standards of return
Allows comparison of projects with different initial outlays Set the cash flows to different discount rates Software or simple graphing allows the IRR to be found
Profitability Index ( 利潤指數法 )
Profitability Index ( 利潤指數法 )
Allows a comparison of the costs and benefits of different projects to be assessed and thus allow decision making to be carried out
Net Present Value
Profitability Index = ---------------------
Initial Capital Cost
Profitability Index ( 利潤指數法 )
Example Company C is undertaking a project at a cost of $50
million which is expected to generate future net cash flows with a present value of $65 million. Calculate the profitability index.
Solution
Profitability Index = PV of Future Net Cash Flows / Initial Investment RequiredProfitability Index = $65M / $50M = 1.3
Investment Appraisal Key considerations for firms in considering
use: Ease of use/degree of simplicity required Degree of accuracy required Extent to which future cash flows can be measured
accurately Extent to which future interest rate movements can be
factored in and predicted Necessity of factoring in effects of inflation